RNG, NOW: Northland Pounds Table on Emerging Cloud Segments

By Tiernan Ray

Northland Capital Markets analysts were busy today with cloud computing stocks, with Michael Latimore initiating coverage of enterprise cloud communications provider RingCentral (RNG) with an Outperform rating, and a $20 price target, and his colleague Tim Klasell raising his rating on shares of ServiceNow (NOW), the outsourcer of IT management, to Outperform from Market Perform, with a $62 price target.

Both stocks are in emerging areas of “software-as-a-service,” versus established cloud outfits such as Workday (WDAY) and Salesforce.com (CRM)

Shares of RingCentral today are up 24 cents, or 1.4%, at $17.15, while shares of ServiceNow are up $2.39, or almost 5%, at $54.52.

Regarding RingCentral, which went public a week ago and soared 46% on its first day, Latimore writes that “the SaaS model is just now starting to reach the mainstream within the business communications technology market,” and that “RNG is an attractive way to invest in the emerging SaaS market.”

The traditional area of “unified communications” hasn’t had much software-as-a-service exposure, he writes, and RingCentral appears to have built a solid product offering:

While the business communications SaaS market may inherently be more fragmented than some SaaS verticals over the long term, we see strong growth prospects for leaders that differentiate on user experience, UC features and price. We estimate that under 10% of the US market has converted to SaaS from on-premises, leaving substantial market opportunity over the next several years. Unified communications has long been a market about to take hold. We believe businesses are widely recognizing now that employee productivity enhancements can occur by unifying communications functions (voice, video, data, fax) and making them accessible to any mobile device. SaaS models enable UC in our view. Also, employees are increasingly relying on their mobile phones for corporate purposes, making corporate communications more flexible and productive, but adding complexity to telephony infrastructure. We see RingCentral as one of the market leaders and beneficiaries of business communications SaaS, UC and mobility. The company built a core software foundation that allows for easy provisioning and management across mobile devices and traditional phones. We estimate RingCentral’s Office service to post $80.4 mil of revenue this year, and $117.5 mil next, up 46.1%. The company is clearly investing for growth and market share, and as such, we expect a loss per share this year of ($0.78) and next of ($0.52).

Latimore values RingCentral, which is not yet profitable, on a multiple of revenue, using comparable SaaS outfits:

We value RNG mainly on its Office (PBX replacement) revenue levels. We estimate such revenue to be $80.4 mil in 2013, and grow 46.1% to $117.5 mil in 2014. The median comp for SaaS companies growing over 25% is 13.7x EV/FY13 revenue and 9.9x EV/FY14 revenue. We give RNG a 25% discount to the comps given business communications SaaS may be more fragmented over the long-term than other enterprise software categories. We use a 1x revenue multiple for the non-Office revenue. A 25% discount to the comps suggests RNG should be trading at about a 10-11x revenue multiple on FY14 estimates in 12 months, or in the $20 range.

As for ServiceNow, Klasell thinks more and more customers, or potential customers, will be buying more of a basket of offerings from the company:

We recently spent some time speaking to new, or soon to be new, customers and integration partners. Not surprisingly the feedback on the product was very positive. What did surprise us were the plans to move from adopting core applications to adopting the platform rather quickly. This is something that not only addresses a larger market but something we think investors assign a higher multiple to, with platform revenues are sticker while offering a more open ended opportunity.

What that means, writes Klasell, is that ServiceNow is moving form being a provider of mere SaaS apps to being an operator of “platform as a service,” which naturally implies selling a broad range of functionality to customers, and should attract a higher stock multiple, he thinks:

Many of the legacy ITSM products in the market had platform extensions as well and IT departments regularly developed custom applications on them. These are increasingly viewed as very dated and developing on them is considered risky from a long term support view as IT departments are fully aware that the world is moving toward PaaS/Cloud offerings. As a result, new project starts on the legacy platforms have been curtailed for some time and users we spoke to have some backlogged projects they would like to start. That said, the initial use cases are still the applications, with Incident Management being the most mentioned as it is the most mature product so migrations are considered less risky is customer feel “it is a good place to get our feet wet” when moving from on-premise to SaaS. While the company does not break out what proportion of their revenues comes from platform versus apps, we think the revenues are less that 20%. Note: last quarter 76% of users had developed one application on the platform, up from 64% the prior quarter. As a point of reference, users had an average of 3.9 applications. While the street certainly values SaaS revenues, we think the stock will also give similar multiples, or better, for PaaS revenues as it enlarges the addressable market. We have noted in the past that Remedy’s platform sales were roughly 50% of its revenues at the time it was acquired by BMC. It is potential that this could be an even larger portion in the cloud world as it is easier to address larger and more geographically distributed users who couldn’t be addressed by legacy systems. Additionally, we think makes the product “stickier” and more of a strategic vendor and “not considered just a trouble ticket vendor” as noted by one technology partner.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.